Market realism: Political development, currency risk, and the gains from trade under the liberal international economic order.

Abstract

I challenge the neoliberal account of the role played by international economic institutions in relations between developed and developing countries. I begin by questioning the conceptual foundations of neoliberal institutionalism, focusing in particular on the relevance of power and interest for discriminating between cooperation, collusion and coercion. I conclude that the laissez-faire policies promoted by international institutions are best characterized as collusion and coercion by powerful countries against weaker countries, based on an assessment of material interests inferred from a revised neoclassical trade model. By incorporating the relationship between currency pricing and traders' confidence in countries' political systems, I derive two critical results. Countries with low levels of political capacity pay more in international markets than countries with high levels of political capacity do, and perfectly free trade is less efficient than an interventionist alternative. The model is supported by empirical evidence demonstrating the relationship between political capacity and currency risk premiums, and by a multinomial logit model in which currency risk premiums successfully predict countries' tendencies to intervene in their currency pricing. My analysis has important implications for understanding how resources are allocated under laissez-faire policies, suggests a basis for the north-south debate over the appropriate rules for international trade, and provides support for structural realist interpretations of international economic behavior.